Visit vanguard.com or contact your broker to obtain a Vanguard ETF or fund prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss in a declining market.

We in Vanguard Investment Strategy Group read. A lot. So it was with great interest that I came across a recent article on Bloomberg about the earnings report from Warren Buffett’s company, Berkshire Hathaway.¹ The article said that cash holdings at Berkshire Hathaway recently topped $50 billion. Now, while Mr. Buffett is known for waiting for just the right opportunity to invest and then doing so decisively, there’s only one Warren Buffett.

It may be easy for us to cherry-pick his results and believe that, because he’s enjoyed such documented success, market-timing can work for anyone. The actual evidence of widespread investor success is sparse, though (for more, see Vanguard’s principles for investing success; in PDF, see pages 27–32). For the rest of us, market-timing is often a negative sum game, where we end up on the losing end of performance.

So as the “portfolio manager” of my family’s assets, I immediately looked at the portion of our portfolio allocated to cash and did some deep thinking. Am I in fact catering to an internal belief that I can pick the right time to invest in riskier assets and falling prey to the very studies that we and others have shown is a loser’s game? Or is cash actually part of my strategic asset allocation? If so, am I comfortable earning 1 basis point of yield in Vanguard Pennsylvania Tax-Exempt Money Market Fund? And what purpose does that allocation serve?

Or instead, should I just view the cash balance as a carve-out of my broader portfolio, serving as a liquidity pool and source of funding should I need it for planned or even unexpected spending, such as getting my driveway replaced this summer (sorely needed, by the way)?

Figure 1:

Notes: Values are purely hypothetical and do not represent actual portfolios.

Source: Vanguard.

Fortunately (now’s the time to accuse me of shameless promotion of my Investment Strategy Group colleagues), Vanguard has a short piece on cash titled “Managing Cash in Your Portfolio.”² Its authors (and my colleagues), Sarah Hammer and Fran Kinniry, outline several considerations that I found helpful. First they write, “Two often-recognized downsides of holding cash are, first, that the money earns very little yield, and, second, that it remains subject to inflation risk.” As an example, since the start of 2000, the Consumer Price Index has increased an average of 2.41% per year (through July 31), while Vanguard Prime Money Market Fund has returned an average of 2.08% per year. Over longer periods, we’d expect cash to return modestly more than inflation, but the point remains. So the question of whether cash should have a permanent place in my portfolio as part of my asset allocation was answered—no, for those keeping track at home.

Second, they clearly state, “Cash should generally be thought of as separate from the rest of the investor’s portfolio … and should be invested in the vehicle that best matches the need.” In terms of answering the question “What should I do?” this is about as clear as one can get (see Figure 1 for an example). The point about the “vehicle” can’t be overlooked. If liquidity and stability are of critical importance, you should evaluate investments such as bonds carefully because of the possibility of loss of principal. Again, for those keeping score, the answer to my other key question about cash’s purpose is that it should be used for emergencies or scheduled spending from a portfolio.

All in all, after reviewing my portfolio and considering the place of cash, I’m comfortable in the size of our allocation and its core purpose. I don’t view it as part of my overall asset allocation. I am fine with it earning 1 basis point because I don’t want to take any excess risk with that pool of capital. And I will not use it to purchase higher-risk assets “when the timing is right.” While everyone has their own unique circumstances, hopefully you find this paper as helpful as I did when thinking about the role of cash.

And to answer my original question… Cash: What is it good for? Absolutely everything (that requires liquidity or short-term spending)!

Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.

Chris Philips

Christopher Philips, CFA, is a senior investment analyst in Vanguard Investment Strategy Group. In this role, Mr. Philips has published and presented research on various topics, including international investing, indexing, and benchmark selection. Mr. Philips joined Vanguard in 2000 and has worked in the Investment Strategy Group since its inception in 2001. He earned a B.A. from Franklin and Marshall College and is a CFA® charterholder.

Comments

Richard G. | November 21, 2015 11:10 am

Mr. Phillips: As you have already referenced in the above blogs, what is appropriate for one person may not be for another.Vanguardians are by and large savers and ergo investors. If a person enters retirement has no debt and does not need any of the proceeds of his IRA/401k to pay anything with then his needs for “emergency” cash will be non existant.They would be using their cash accounts to take care of extras, charity giving,buying things to help spoil their grandchildren ect. The other end of the spectrum is a investor who has debt and must depend on his cash position to provide a buffer to keep from selling stocks during a recession corection in the market plus needing cash to help pay bills due to his debt load. There is a lot more pressure on this person and they would be prudent to increase their cash cushion out to the three to four year range of their expenses.I can tell you that I am lucky to be in the former position and in retirement if I do not have cash to buy it It does not get purchased.Good Luck to All.

Richard G. | November 10, 2015 10:49 pm

Mr. Phillips: Another great article sir please keep them coming.I am retired and all that I am managing at present Is my IRA that I have at Vanguard.If you are retired and are debt free then your cash requirements are going to be a lot less than a person who has college debt,four outstanding charge card accounts and they are in hock up to their eyeballs.Right now i am in the former condition-have very little debt and receive five retirement checks over a almost 45 year work history.I keep a healthy (two years salary) in cash as both a buffer to not be forced to sell stocks or bonds until I want to not due to a correction.Also to handle emergencies that may arise with your family,your home ,cars washing machines etc.etc.I have no taxable portifolio with Vanguard now but when RMD’s arrive at 701/2 then i will begin a new use for my cash account possibly involving investments in tax-deferred,taxable and in the tax free arena.I really am in a quandry as to how to best arrange all of this but I bet that there is an adviser at Vanguard who can help me with this problem.Good Luck to all with your investments.

Howard E. | November 6, 2014 4:55 pm

My long term method of having an available cash acdcount is as follows.

I think I need half of my current annual spending as a cash account. So I put 150% of that amount of money into a relatively conservative stock index mutual fund, assuming that the worst I could expect from that fund in an exceptionally bad year would be a 33% loss, looking at 2008 as a bear year example.

The next two years, the market did so well that the ” available cash account fund” had increased enough so that I moved 10 % out of that account into my normal investment portfolio, and things look good enough that I can continue keeping my “cash reserve” earning money for me.

I can consider that money as cash, because I have other Vanguard mutual funds as part of my investment portfolio along with a Vanguard sweep account that I can write checks on. So if an emergency comes along where I need immediate cash, I just call Vanguard and have them transfer as much as needed to meet the emergency, which means I can write a check on the sweep account the next day.

This logic, plus the restraint to stick with it , has really worked for me. So well that I have reviewed my investment portfolio, and eliminated all low interest fixed income in favor of conservatively selected relatively high income equities.

Christian R. | October 23, 2014 5:56 pm

You make a big logical leap going from Buffett’s holding cash while waiting for great opportunities, and discussing market timing. Buffett has ever advocated market timing, his cash is simply the outcome of not having enough compelling opportunities.

Buffett’s concentrated investment style is very different from the low cost, diversified style that Vanguard is famous for. Both can be extremely effective, but what works well in one can’t always be applied in the other. In a long term diversified portfolio, cash is probably a detractor from performance. In a concentrated portfolio of individual stocks, cash may be exactly what the investor needs to take advantage of future opportunities that the investor can identify. No market timing is required, just the ability to value some assets and the patience to wait for a large mismatch between price and value.

The view that cash equals market timing is a red herring, and not necessary to prove your point.

Leonard S. | October 23, 2014 10:48 am

What is practical difference: whether as expressed as percentage of total or as flat amount, it is part of asset investment? What is under-discussed generally is issue of age; a 55 year old has time to ride out a correction but a 70 year old during today’s declines, for example, is in a much more perilous situation, even with an index fund.

Leonard,
Thanks for your comment. I agree that in many cases the asset allocation and riskiness of a portfolio will be different for a 55-year-old individual versus a 70-year-old. The issue of time horizon and an investor’s unique circumstances are at the heart of setting an appropriate asset allocation. This is something we at Vanguard have written volumes on. But perhaps a great place to start is by reading our Principles for Investing Success, which I mention and link to in the post.

Tom M. | October 21, 2014 7:09 pm

I agree with your assessment. In terms of how much cash you should maintain, one factor to consider is where you are in your investment “lifecycle” — e.g., whether you are accumulating assets vs. whether you are in retirement. While I’m a DIY investor and a huge Vanguard fan, I look at investment ideas from a lot of sources. One financial planning / advisory firm I follow recommends that those in retirement maintain 3 years of expenses in cash, because it will allow you to feel comfortable riding out the inevitable down cycles of the market (i.e., avoid selling when the market is down). They landed at 3 years because that can be how long it takes for markets to fully recover from some downturns. They recommend you feed this “bucket” with dividends, capital gains distributions, and via periodic portfolio withdrawls / rebalancing, if needed. Seems like a good concept.

Tom,
Thanks for your comment. The amount of cash one elects to hold can be driven by any number of variables. The desired exposure to market volatility and loss may certainly be one of them, but in most cases probably shouldn’t be the only one. In the paper I referenced, we do recommend a range of 3-36 months of living expenses to be held in cash, but 3 years may not be appropriate for everyone.

Jay S. | October 23, 2014 4:25 pm

I can think of times when a 60/40 portfolio didn’t come back in 3 years. I don’t disagree with the bucket approach, but to believe that a portfolio will rebound from a sharp drop within 3 years may be dangerous.

Paul D. | October 13, 2014 4:31 pm

Thank you Mr. Phillips for your very nicely articulated posting. For us old-timers in the investing world “Cash is King” was a phrase we grew up learning first hand. All the more reason I was attracted to Vanguard many years ago….the less I pay to invest, the more I get to keep is fundamentally, flawless.

First, you need cash in order to build that ‘well diversified portfolio’ to invest for your future and, you need cash in order to merely survive in the meantime. Secondly, juggling the various priorities that each of these separate goals require while “life happens” helps develop discipline and prudence in the use of cash.

I use cash completely separate from my investment portfolio. I find that it enables me to “not care” what’s happening in the market at any given moment and focus on enjoying my retirement. I know I couldn’t do that if I didn’t have enough cash to begin with (ergo, Cash is King). Cash is just another tool in the box, but it doesn’t matter how many tools are in the box if no one knows how to use them properly, and proper use of cash is one area where Vanguard excels.

Advice I have read in many places is that periodically, say once a year, one should review one’s portfolio. One should ask oneself, based on what I know now, would I invest in this stock or mutual fund? If the answer is “No”, then you should seriously consider selling it and moving your investment to something else.

Five+ years ago there was a well-known financial man (Bogle?) who sold and avoided losses just before the big stock market drop. He didn’t credit any market-timing insight. He had only reviewed his portfolio, and realized that it was riskier than it should be for a man of his age. He rebalanced it.

David,
Thanks for your comment. We also recommend a periodic review of one’s portfolio to ensure that the mixture of assets is not out of balance. During periods of significant market advance, this becomes a critical tool in managing the overall risk one is exposed to. Unfortunately it’s against human nature to sell winners and buy losers, which is why rebalancing is so difficult to do.

David O. | October 9, 2014 10:42 pm

Advice I have read in many places is that periodically, say once a year, one should review one’s portfolio. One should ask oneself, based on what I know now, would I invest in this stock or mutual fund? If the answer is “No”, then you should seriously consider selling it and moving your investment to something else.

Five+ years ago there was a well-known financial man (Bogle?) who sold and avoided losses just before the big stock market drop. He didn’t credit any market-timing insight. He had only reviewed his portfolio, and realized that it was riskier than it should be for a man of his age. He rebalanced it.

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At Vanguard, we’ve always believed in candid, direct communication with investors. In fact, it’s one of our core principles. In 2009, we created the Vanguard Blog so that we could talk about what’s happening in our industry and in the economy—and hear what’s on the minds of investors like you. More

Visit vanguard.com or contact your broker to obtain a Vanguard ETF or fund prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss in a declining market.